Chapter 10 Making Capital Investment Decisions

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Key concepts and skills Project Cash Flows Relevant Cash Flows The Stand-Alone Principle Incremental Cash Flows Sunk Costs Opportunity Costs Side Effects Net Working Capital Financing Costs Other Issues Pro Forma Financial Statements and Project Cash Flows Getting Started: Pro Forma Financial Statements Project Cash Flows Projected Total Cash Flow and Value More about Project Cash Flow A Closer Look at Net Working Capital Depreciation Evaluating Equipment Options with Different Lives Project Cash Flows Relevant Cash Flows Cash flows that occur (or don 't occur) because a project is undertaken. Cash flows that will occur whether or not we accept a project are not relevant. Incremental…show more content…
Accounts payable also tends to increase to support the higher inventory levels; however, the cash flows associated with these increases do no appear on the income statement. If they aren 't on the income statement, they won 't be part of operating cash flow. So, we have to consider changes in NWC separately. Later, as projects end, this investment is often recovered. Financing costs Ignore! We generally don 't include the cash flows associated with interest payments or principal on debt, dividends, or other financing costs in computing cash flows. Financing costs are part of the division of cash flows from a project to providers of capital and are reflected in the discount rate used to discount the project cash flows. Other Issues Use after-tax cash flows, not accounting numbers. Note: Investing in fixed assets differs from investing in financial assets in at least one important sense. It is easy to find the investment opportunity and then perform an analysis to decide among competing opportunities. Preparation of a capital budget, on the other hand, requires that people investigate and develop new project proposals, estimate the cash flows associated with these projects, and only then perform the analyses. Developing reliable cash flow estimates ranges from being a relatively minor task (say a simple replacement project) to one that is subject to a great deal

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